[Jess774]

One of my Becker MCQs:

When debit is issued at a discount, interest expense over the term of debt equals the cash interest paid:

plus discount

For some reason, my mind constantly thinks that I should be subtracting the discount. Would somebody possibly try to help me understand why I am adding the discount?

Also (maybe this is a silly question), should I assume that they are asking about the bond issuer or bond holder? Or would the discount count be added for both the issuer and the holder?

REG - 75
BEC - 70, 64, 81!!!!
FAR - 67, 69, retake: Oct 2016
AUD - 8/25/16

[confusedcandidate]

You should assume it is from the perspective of the issuer because it is asking for interest expense.

This debt was issued at a discount, so the issuer got LESS cash than the face value of the debt would suggest. Therefore, you have to add that discount to the total interest expense. We do that by amortizing the discount every payment period, instead of recognizing the entire discount as an expense all at once.

Think of it this way: you are issuing the debt at a discount because your note % yield is less than market rates. By expensing the discount along with interest expense, you are effectively paying the same rate as the rest of the market. Instead of higher cash interest payments though, you just got less cash at issue. Net to net it's still the same, just a timing difference of cash flow really.

Weekends are meaningless to a CPA candidate

[ewbzach]

I always try to think of it from the stand point that you buy the loan for less than the face amount causing you to record a discount. As time passes the amount of this discount will need to be amortized/accreted up to the face value of the debt. This is because the stated rate on the debt is less than the market market/prevailing/effective rate (whatever you want to call it).

So for every month you record interest the effective amount will be greater than the state interest on the debt per period. The difference between the two is the amount of the discount that you will amortize/accrete for the period which is added back to the original discounted price you payed for the loan. Again, this discount will amortized/accreted UP to the original face value of the debt.

Just wanted to give another view point from #confusedcandidate.

[Anonymous]

Simplified…Discounts increase interest …Premiums reduce interest …

[jm962011]

I think Roger has a free YouTube video that explains Bonds. I started out with Becker and was completely lost on Bonds but Roger helped cleared it up for me.

[Jess774]

Thanks a lot guys!! Very helpful.

REG - 75
BEC - 70, 64, 81!!!!
FAR - 67, 69, retake: Oct 2016
AUD - 8/25/16

[Author]

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